Life Insurance:Critical to Your Financial Foundation

Let me tell you a story about the importance of being protected by life insurance.

I have an old friend who used to sell life and health insurance. One of her clients referred her to his friend – a family man with six children, ranging in age from 4 to 17. His mother also lived with them. He was the sole support for his family. They had to be cautious with their money to make ends meet, but when his friend told him he should have life insurance to protect his family, he decided to check it out.

My friend met with the man and his wife, and they decided to buy an inexpensive term life insurance policy for each of them.

Less than two months later my friend the agent received a frantic call – this father of six and sole support of the family had been killed the night before when his van was broadsided by a car that ran a red light. He was just 38 years old.

It was tragic. The family was inconsolable. But because he had taken out a life insurance policy just two months before, the life of this close knit family stayed intact. They were able to remain in their home and put food on the table. They were able to grieve their loss without also having to worry about how they would survive.

The two months of coverage had cost them less than $30, and now the insurance company would give them $100,000.

Out of respect for the family, my friend attended the man’s funeral. It was a different experience for her because the family was of a different culture and followed traditions that were unfamiliar to her. She became very uncomfortable when the deceased man’s mother clung to her arm and, through her tears, spoke loudly and rapidly in her native language. My friend was positive that she was blaming her for his death because she had sold him insurance on his life, and she felt terrible. But a cousin came to her and translated. “She is thanking you,” he said. “She says she doesn’t know what they would do if you had not helped them.”

I was touched by this story when it happened, and I’ve never forgotten it. What an amazing example of how quickly life can change – and how devastating it can be if you don’t have the proper protection in place.

There are several types of life insurance policies available, and they fall into two categories: term and permanent.

Term Insurance is life insurance coverage that you have for a temporary, specified term, or period of time, as long as you pay the premiums. There is no accumulation of cash value. Policies vary based on face amount (amount of coverage), premium (cost of coverage), and the length of coverage. Term polices fit into four basic categories:

Level Term: The face amount and the premium are fixed, or remain the same, for the specified period of the policy.

Increasing / Decreasing Term: The premium remains level for the specified period while the face amount either increases or decreases over the life of the policy.

Renewable Term: The policyholder has the right to renew the policy at the end of the term without having to prove they are still insurable. The premium increases at each renewal as the policyholder gets older. Annual Renewable Term is one example of this type of policy.

Convertible: The policyholder has the right to convert the policy into a permanent insurance policy without having to prove they are insurable.

Term insurance is by far the most affordable life insurance when you are relatively young and healthy. As in the story above, it is great for covering the breadwinner in the family to be sure the family’s lifestyle can continue if that person’s death wipes out the family’s income.

As you get older, term insurance becomes more and more expensive, and eventually it is not feasible to pay for term coverage. The hope is by that time you are in a different stage of life where a lower amount of insurance is needed just for burial expenses rather than the larger amount needed in earlier years to replace income.

Permanent Insurance stays in force for the life of the insured, as long as the premiums are paid. It accumulates a cash value that can be borrowed or withdrawn, but any use of the cash value lowers the face value of the policy.

Whole Life: The most common or basic type of permanent insurance policy, and the most expensive. It accumulates cash value based on the performance of the company’s investments. The policyholder has no say in managing the investments. After 15 years (plus or minus a year or two) the policy may have enough cash value to pay for itself with dividends so the policy holder can stop making payments. The drawback to this is that it basically stops the growth of the cash value.

Universal Life: Premiums are flexible so the policy owner can direct how much money goes into the investment side (cash value) of the policy. The cash value typically earns market rates, and the policy holder has no say in how the money is invested. If the investment does well the cash value can be used to pay the premiums, or it can be used to increase the face amount of the policy without having to prove insurability.

Variable Life: Fixed premiums like Whole Life. The policy holder chooses how the cash value is invested within the choices offered by the company. It can be directed to several separate funds that operate like mutual funds, and can be invested in stocks or bonds. The face amount may go up or down depending on how well the investments perform. Often the face amount can be fixed for an additional premium amount. Variable Life is considered a security and can be sold only by an agent with a securities license.

Variable Universal Life: The best of both of these policies, VUL provides the premium flexibility of Universal Life with the investment opportunities of Variable Life. The performance of the investment may affect the face amount of the policy. Like Variable Life, this is a security and can be sold only by an agent with a securities license.

Premiums for permanent insurance are higher than for term insurance, and they remain the same for the life of the policy. For this reason it makes sense for a young person to buy permanent life insurance – at least a small policy – so they will have at least enough for burial expenses when they’ve been forced by cost to let their term policy go. The premium will be relatively small, and stay small for as long as the policy is in force.

Buying a small permanent policy for your child is also a good idea. The premiums will be relatively low, and it gives you something to pass on to your child as they enter adulthood. It gives your child a head-start in planning for his or her own family’s protection needs.

Regardless of the type or amount of life insurance you have, it is important to review and update your coverage as you move through the various stages of your life. Your needs are different as a newlywed than they will be when you retire. And major life changes such as a new child, a job change or promotion, or divorce are also good times to review and adjust your coverage.